10 Small-Cap Stocks With Earnings Surprises - 11419 views

By Scott's InvestmentsContributor
03/17/11 - 04:17 PM EDT

The following commentary comes from an independent investor or market observer as part of TheStreet’s guest contributor program, which is separate from the company’s news coverage. The opinions expressed are those of the author and do not represent the views of TheStreet or its management.

NEW YORK (Scott's Investments) -- Below is a list of 10 small-cap stocks with recent earnings surprises to consider in the short (or long) term.

For the purpose of this monthly list, I define "value" as a stock with a projected current-year P/E of under 20 and a price-to-earnings-growth ratio under 1. "Small-cap" is defined as having a market capitalization under $1 billion. An "earnings surprise" is defined as a stock that has beaten estimates the past two quarters and has an average earnings surprise of 20% or more for the past four quarters. I also require stocks to be trading above their 200-day simple moving average. I use stockscreen123 as the tool and screener.

As I've stated in the past, this is a "risk-on, risk-off" trade. Even before the disaster in Japan, equity investors recently began taking profits. As investors take the risk off the table, screens such as this one may suffer.

Why do I track this screen? I find PEG an effective ratio for identifying growth stocks at a reasonable value. In addition, a recent history of earnings increases could, in theory, help identify companies with the ability to continue to surprise.

Backtesting this screen with a rebalance period of every four weeks and a maximum position size of 10% (in instances when fewer than 10 companies qualify) has produced solid five-, three- and one-year returns (see December's list for a backtest). A quick visual inspection shows this screen has done well as a high-beta play, outperforming in positive market environments and struggling in down markets. Also, a four-week rebalance period can lead to high turnover and transaction costs.

I exclude OTC stocks, and I further narrow the list based on additional stockscreen123 fundamental factors to 10 stocks or fewer. The list, as always, is not a specific portfolio but a recommendation for further research. Since this is a purely mechanical screen, I play no discretion in the results (other than establishing the original screen criteria). Of note, Metropolitan Health Networks (MDF) has been a qualifying stock on this list since May but is no longer on this month's list due to a recent earnings surprise coming in at 2.41%, less than the required 20%.http://elite.finviz.com/publish/031511/MDFccdl23003816.png

This month's list consists of the following 10 stocks (no disclosures):

Scott's Investments focuses on consolidating and tracking free online investment resources for the public with an emphasis on ETFs, portfolio/trading strategies and macroeconomics. Follow Scott's Investments on Twitter.